Japan Central Bank Instates Negative Interest Rates

By John Gallagher,
International Business Assistant Editor

Japan’s economy has been plagued by an aging population and chronic deflation for the past two decades. Prime Minister Shinzo Abe’s plan to revitalize the world’s third largest economy, commonly known as “Abenomics,” has failed to spur inflation to the sought after 2 percent threshold and has not been able to revitalize growth in the stagnated economy.

Deflation, a decrease in the prices of goods and services, has been persistent in Japan for the last two decades due to a lack of demand caused by a shrinking population and an overall reluctance to admit immigrants into the country. The lack of demand translates to stagnant or decreasing corporate sales growth. To combat the lack of demand, businesses decrease prices in an attempt to increase sales. This leads to price wars between competing companies thus they are forced to cut labor costs to remain profitable. When jobs are lost, demand decreases further, adding to the problem and spurring potential deflationary spirals.

Once consumers develop a deflationary mindset, they tend to postpone purchases. If the price level is going to decrease in the future, it makes more sense to wait until prices fall than it does to purchase now. Inflation is desirable because it works in the opposite way. If prices are expected to rise, consumers will make purchases now rather than in the future when higher prices can be expected. This leads to an increase in demand which creates jobs, boosts corporate earnings, and rewards shareholders.

Abenomics, launched in the beginning of 2013, is a three arrow approach to revitalizing the once robust Japanese economy. The first arrow is monetary policy, the second is fiscal policy, and the third arrow is focused on structural reforms.

Monetary policy has been the main focus and the center of the dialogue surrounding the Japanese economy, as the Bank of Japan has printed trillions of Yen to buy back bonds and increase the flow of money in the economy. If more money is chasing the same amounts of goods, then supply and demand says that the prices of those goods should rise, but that hasn’t been the case.  It seems as if Prime Minister Abe’s attempts to achieve a consistent inflation rate of 2 percent has fallen short. After achieving an impressive inflation level of 2.38 percent in 2014, 2015 inflation levels fell to just 0.18 percent.

In order to combat the low inflation environment, the Bank of Japan announced negative interest rates on deposits by banks on January 29. The goal of this is to encourage banks to lend money rather than to store it at the central bank. Analysis by the magazine, The Economist, shows that the Yen temporarily depreciated in value after this announcement. Almost immediately after, the European Central Bank announced additional easing, prompting investors to send their money to Japan, a perceived safe haven. This caused the Yen to appreciate significantly against most other major currencies. A stronger Yen hurts the Japanese economy because of their reliance on exports to places like China and the United States. When the Yen appreciates, Japanese goods are more expensive to consumers, lowering demand for their products and hurting Japanese corporate earnings.

The Yen is currently 5 percent stronger than it was a year ago and has appreciated 10 percent from its lowest value in the past year.

A version of this article appeared in the Tuesday, February 23rd print edition.

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